accounting essay

Importance of Corporate Governance to Business

Published: 23, March 2015

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For the intervention of investors to invest in any business, businesses around the universe need to develop and be upgraded in their particular field of business. Investors need to be informed that the businesses are capable of improving and developing their business financial status by the means of strong and capable management (Mallin, 2007). The investors need data and information to assist them in making decisions. The data and information may be obtained from many sources, mainly from annual reports and financial statements.

Investors need to be committed and deeply look into the business published annual reports that reflect the business well being and expose it operations standards (Mallin, 2007). Information that is looked for by investors in any business is the company performance. If the business performance and management is lacking and not encouraging, this would lead to business insolvency and collapse, which had happened in some global companies, such as the case of Barings Bank and Enron.

The liquidation of Baring Banks in February 1995 is an example of risk that occurs when financial management is not on the right control system. Another example is the scandal of Enron's collapse which is one of the mighty collapses in the world. It is a collapse that also leads to another collapse of one of the largest audit firm in the world (Arthur Andersen). The main cause of the collapse is due to the financial manipulation. Another competent example is what has been exposed by Jong, DeJong, Mertens and Roosenboom (2005), Royal Ahold was a successful company in the 1990s but later in 2003 had been in a failure list through the result of it failure in its corporate governance.

The Asian financial crisis of 1997 came out in Asian countries with the attention and the interesting to seek to strengthen their corporate governance, disclosure and transparency levels (Ho & Wong, 2001). In the case of Malaysia, the reason of investor confidence eroding was suggested to be brought by the Malaysian's poor corporate governance standards and a lack of transparency and quality of disclosure in the financial system (Noordin, 1999). Therefore, the effectiveness of corporate governance control system is considered crucial in aligning the interests of directors with those of shareholders.

The board of directors has major role in corporate governance; its main responsibility is to endorse the strategy of the organization, remunerate senior executives, appoint, supervise, and develop directional policy and to ensure organization's accountability to its shareholders, authorities and other stakeholders. The qualified effectiveness of corporate governance has a deep impact on how well a business be performed. The literature on corporate governance largely identifies characteristics of the board and their influences on the organizational outcomes. Previous studies have examined the impacts of such factors as board composition (Baysinger & Hoskinsson, 1991; Chaganti, Mahajan & Sharma, 1985; Kosnik, 1987; Schellenger et al, 1989) and board size (Dalton, Daily, Ellstrand & Johnson, 1999; Pfeffer, 1973; Pfeffer & Salancik, 1978; Singh & Harianto, 1989) on strategic decisions and performance of organization.

The Listing Requirements of Bursa Malaysia has specified that the board of directors of a firm should be made up of at least two or three persons of the outside directors to ensure the accountability and the liability towards shareholders. The Code endorses the same requirements to the effective utility of the board. The outside directors might contribute to the board to poise the board size and to operate collaboratively with their executive colleagues and offer independent judgment when necessary. The risk might be greatest when the roles of chairman and CEO are united. Thus, the presence of a sufficient number of outside directors is crucial (Ponnu, 2008).

Corporate governance:

Definitions of corporate governance can be many, for instance; corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or organization) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, the board of directors, employees, customers, creditors, suppliers, and the community at large. (Wikipedia)

Corporate governance is a multi-faceted subject (Dignam, A and Lowry, J (2006). An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem. A related but separate thread of discussions focuses on the impact of a corporate governance system in economic efficiency, with a strong emphasis on shareholders' welfare. There are yet other aspects to the corporate governance subject, such as the stakeholder view and the corporate governance models around the world (see section 9 below).

There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large U.S. firms such as Enron Corporation and MCI Inc. (formerly WorldCom). In 2002, the U.S. federal government passed the Sarbanes-Oxley Act, intending to restore public confidence in corporate governance

"Corporate governance is the process and structure used to direct and manage the business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realizing long term shareholder value, whilst taking account the interests of other stakeholders". Report on corporate governance (2002)

Also, regarding to (Parkinson, 1994) "The process of supervision and control intended to ensure that company's management acts in accordance with the interests of shareholders" . and also "Corporate governance is the system of checks and balances, both internal and external to companies, which ensure that companies discharge their accountability to all their stake holders and act in a socially responsible way in all areas of their business activity"(Solomon & Solomon, 2004)

Corporate Governance in Malaysia

The introduction of corporate governance in the public listed companies took place in the year 1993, when the Bursa Malaysia listing condition and criteria made audit committees compulsory (Haniffa, 1999). Good corporate governance practices were further emphasized by the Malaysian Securities Commission following the move from a merit-based to a disclosure-based regulatory regime in 1995. However, the economic crisis in 1997 that saw a number of 'blue chip' corporate failures, such as Renong, UEM and KFC (due partly to a lack of effective corporate governance mechanisms), fast forwards the implementation and the adoption of the process. By then, the intervention of the government enhanced the establishment of 'Finance Committee on Corporate governance' in March 1998 which is embodied a high level representatives from the government, regulatory agencies, industry bodies, and different professional associations. Basically the function of the committee is to set a revised corporate governance practices task and to assign lawful actions in maintaining the effectiveness and efficiency of the corporate governance.

The committee had identified several factors that lead to poor corporate governance, which were lapses in corporate governance exposed by the committee, the amount of boards of directors productivity, personality, shareholder convince and conduciveness, enforcement techniques, and lack of responsibilities knowledge by directors (Othman, 1999).

However, personalization and ownership dominated problems in Malaysia is not excluded from most industrialized nations' control and management. The entire shareholders can be dominated with control right and this kind of domination some few shareholders in a high risk and there will be a high rate of doubting of boards activates and reactions (Claessens, Djankov & Lang 1999). Particularly those who are not part of management are most of the time perceived as a 'rubber stamp' and are selected for reasons other than monitoring (Haniffa & Cooke, 2002). Accordingly the economic rise that evolve in the early 1990s degree the status of small companies owners to complex law and statutory requirements followed by the process of selling of companies share publicly (Othman, 1999). These changes lead both external and internal shareholder to be highly motivated in demanding a better corporate governance operations in the public listed companies. Conclusively the method for maintaining the overall corporate governance has never been enough, and the banalities for unlawful un-adherence have also been relatively low, or even insufficient to the extent of protecting the existence of deterrence, particularly during the time of economic downturn of the listed companies (Othman, 1999).

Code of CG - discuss relating to the Malaysian law:

The Malaysian Code on Corporate Governance is the major keystone of the corporate governance reforms agenda in Malaysia. It affords guidelines on the principles and great practices in corporate governance and the way for the implementation in addition to charts the future potentials of corporate governance in Malaysia. Corporate governance plays the major role in firm performance because it supports the control mechanisms business operations.

In March 2000, the FCCG issued the Malaysian Code of Corporate Governance (MCCG) regarding the requested and proposed Code on Corporate Governance issued in February 1999. The MCCG is mainly extracted from the criteria of the Cadbury Report (1992) and the Hampel Report (1998) in the UK. The main result of the recommendations set out in the MCCG are emphasized and summarized into four main groups; recognized principles, good practice, strong persuading of other participant, and influencing best practice (FCCG, 2000).

The recognized principles are basically focused on four areas; board of directors, directors' remunerations, shareholders, accountability and audit. Aiming with the principles components to allow a free passive action by the companies based on inconstant conditions and circumstances of personal companies. A reporting statement in the annual report, narrating the way the principles have been applied as a satisfying application to greatly attract and invite investors and others to benchmark companies performance and government practice, and also to reply significantly to their assessment in an informed way (FCCG, 2000).

The features of a good practice which is used to emphasize some precautions of board of directors practices and identify a set of guidelines in company accountability and audit with the aim to enhance the corporate governance. The set of guidelines is to be voluntary complied by companies by reporting in their annual published report the level of compliance to the code explaining the reasons for not complying with such practices (FCCG, 2000). The persuading of other participant features is an explanation phase to the investors and auditors to influence development and effectiveness of the companies' corporate governance. Explanatory notes, fully present the explaining actions and practices on the general function of the principles. However, the influencing best practice exposes the direction of practice in the companies (FCCG, 2000).

One of the functioning aims of the MCCG is to provide techniques and ways for investors to restore confidence and believe in companies' management, the productivity of the assigned governance system in developing corporate operations based on experiment rather than ideas and theories. In conclusion, this study emphasizes the effectiveness and the productiveness of corporate governance by carrying out examination on the impact of board quality on the performance of Malaysian construction and technology companies.

The Important Role of the Board of Directors

In any company the board of directors cannot be underrated through their performance in companies operations. It is overrated as high management and it is in charge of monitoring and supervising the company's resources and operation as its focused responsibilities. The board of directors is functionally seen as a team of gathered personalities, with trustworthy responsibilities of jointly leading and directing a company, with their basic aim to be the firm's shareholders interest's protection (Abdullah, 2004).

Theoretical views have highlighted three different roles of board by many authors as follow; services role, control roles and strategic roles (Zahra & Parce, 1989; Gopinath, 1994; Maassen, 1999). The roles are further explained and analyzed in a different study that, board should simultaneously appear in auditing, supervisory, coaching, and steering (Strabel, 2004).

The difference between ownership and control techniques in recent organization has ended in a vulnerability of interest solutions (Berle & Means, 1932). This happens to be one of the agency theory deficiency in which using self interest of management system can easily result to value-reducing activities (Jensen & Meckling, 1976).

Corporate governance has long publicly showed the evidence of supporting the significance and the efficiencies of board of directors on the present and future of firm performance (Baysinger & Butler, 1985). The technique used in corporate governance is seen as an elaborated means of creation and building of worthless interactions and collaborations with various stakeholders in firms' performance as well as the firm human resources (Gilbert & Ivancevich, 2000). For the fully enhancement of board of directors in firm's future wealth-building, successful performance and survival, the corporate governance building instrument must not be in the same nature (Westphal & Milton, 2000).

Legal environment of corporate Governance

In the United States, corporations are governed under common law, the Model Business Corporation Act, and Delaware law since Delaware, as of 2004, was the domicile for the majority of publicly-traded corporations (Bebchuck LA" The Case for Increasing Shareholder Power "(2004). Harvard Law Review. Individual rules for corporations are based upon the corporate charter and, less authoritatively, the corporate bylaws (Bebchuck LA2004). In the United States, shareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws (Be chuck LA2004). In the UK, however, the analogous corporate constitutional documents (the memorandum and articles of association) can be modified by a supermajority (75%) of shareholders (Be chuck LA2004). Shareholders can initiate 'precatory proposals' on various initiatives, but the results are nonbinding. Precatory proposals which have received majority support from shareholders, even for several consecutive years, have historically been rejected by the board of directors (Be chuck LA2004). However, there are many factors which are effect on shareholders. The following eliminates will illustrate and analysis the legal environment of corporate Governance:

1: Accounting and disclosure requirements

In a perfect market, all the Law needs to do is to define property rights and enforce contracts1. In that spirit, Watts and Zimmerman (1986) argue that disclosure standards should emerge as solutions to individual contracting problems between firms and financiers. The complexity of legally mandated accounting standards for public disclosure suggests that the contracting costs of individualized reporting standards are prohibitive. Also, investors want to compare performance across firms, making standardization desirable.

Whether the reporting standard should be defined by a professional ssociation or the legislator is a different level of debate. Whittington (1993) discusses the trade-offs between public and private regulatory bodies. While the latter suffers a potential enforcement problem in the presence of free-riders, the former may be less flexible in its evolution. Whittington argues that self-regulation is - at best - a transitory phenomenon. In practice, there is a division of labor between expertise (private standard bodies), and enforcement (the Law).

Another question is the suitability of accounting standards pertaining to corporate governance issues. Benston (1982) argues that accounting measures are too coarse to compete with governance mechanisms aimed at the accountability of individual managers. While accounting information can support a conclusion that "a firm is doing good or bad", it is not suitable to support (and verify) a statement such as "a manager is doing good or bad".

Hence, disclosure of corporate information based on accounting standards is necessary for distant investors to make a financial decision, but it is not sufficient to trigger managerial replacement or other individually targeted action. Moreover, recent evidence suggests that accounting data are anyhow just a very crude information source. Rangan (1998) and Teoh, Welch and Wong (1998) examine seasoned equity offerings in the USA to conclude that firms use available discretion to over-report earnings prior to such offerings, and that a significant portion of post-issue underperformance can be attributed to investors not rationally absorbing all available information.

Furthermore, Alford and Jones (1998) compare US companies with foreign firms listed in the USA, which are exempt from certain SEC registration and reporting requirements. They conclude that their evidence does not allow the inference that the less stringent requirements on the foreign firms lead to greater information asymmetries. Of course, a plausible explanation could be that listing requirements on US exchanges are stringent enough to signal firm quality to investors, and that SEC regulation adds only little value on top of that. In countries with less stringent exchanges, the Law may take a greater role. Accounting information and disclosure standards can be thought of as a rather crude measure to aid investors, but they do have a role in helping markets to function 'better'.

2: Regulation of shareholder voting: rights and conduct

Pound (1991) looks in detail at the role of the SEC in shaping a governance framework for market participants to act in. While the efforts of the SEC to regulate shareholder communication and voting must also are seen as an effort to limit (fraudulently motivated) market failure, the results seem to confirm the proverb: "The road to hell is paved with good intentions."

Pound documents how the SEC's efforts have increasingly stifled shareholder activism, possibly leading to further management entrenchment. In 1992, the SEC has changed its rules, but up to that point, a shareholder, who communicated his ideas to more than 10 other shareholders, was acting in violation of SEC regulations. According to Pound, this has increased the cost of proxy fights substantially. Thus, proxy fights tend to focus on contests for full control, rather than on more marginal issues such as the divestiture of parts of a business. The regulation induced costs of proxy contests has reduced the effectiveness of shareholder activism.

A similar force was at work in Germany, albeit from a rather different corner. The 1976 Codetermination Law granting labor participants a seat on the board has consistently reduced the number of decisions which the management board has to present to the supervisory board for approval. The result was diminished communications between shareholders and management, which equally led to diminished shareholder activism. Yet, in the spirit of the analysis of chapter 1, we might argue that this may not have reduced the value of the firm much, if any. Increased management entrenchment is only a negative, when managers can rightly feel that they are accountable to nobody. Neither in the USA, nor in Germany is this the case. In that sense - while not intended that way - legislation that reduces the effectiveness of shareholder activism grants some degree of independence on managers that is vital to execute efficient leadership in large organizations.

3: Regulation of takeovers

While disclosure laws and proxy regulation are passed so that markets can function better, takeover laws - especially those passed in the late 1980s in the USA - can serve to limit the functioning of markets. The literature on US anti-takeover laws has been discussed above, and has yielded mixed results. Similarly, we argued that takeover defense mechanisms installed by management rarely have negative consequences for shareholder wealth. Schwert (2000) argues that they merely improve the negotiating positions of target management. Then, a hardly noticeable effect of anti-takeover laws shouldn't come as a surprise.

Yet, if anti-takeover defenses and laws are of limited importance, the US is - by itself - not a suitable laboratory to examine the effect of the relevant legislation. In a study comparing the UK, France and Germany, Franks and Mayer (1990) concluded that the different level of takeover activity in the three countries was to a significant extent due to regulation rather than market forces. Takeover legislation is then part of a whole package of financial market legislation, and the legislative portfolio has been shaped over time to yield an internally consistent regime, but one that may take very different forms. We talked above about substitution effects between different governance mechanisms. What is true for different governance mechanisms invented by market participants seems to be equally true for the legislative portfolio, albeit in a more inflexible framework over time. Takeover legislation may serve as an example for this pattern.

4: Corporate charters

The SEC and equivalent organizations in other countries regulate institutions that wish to sell financial claims in public markets. Yet, in most economies this is only a small fraction of companies, even when measured by the share of totally produced revenues they account for. All other firms have their degree of negotiating freedom limited at least in part by laws offering corporate charters. A firm can decide between charters depending on whether it wants more than one shareholder, if these shareholders want to commit to the venture with their full wealth, if they want to limit their liability, if they want to receive their gains in the form of profits or improved purchasing conditions (co-operatives), or if they want to have traded securities that are easy to liquidate.

Shareholders can decide which option appeals to them the most, but each option is regulated by the legislature: if you decide on a give option, you are bound by the rules. This is, of course, the argument by Hansmann (1988) that ownership is in part endogenous: firm's structure in a way that they see fit.

5 Regulation of the board of directors

One element of regulating corporate charters of public corporations is to prescribe form and conduct of the board of directors. In France, companies have the choice within the Law to select a monist or dual board. In Germany, the supervisory board is expressly prohibited to meddle in management's operating decisions, and focus on supervisory activities exclusively. Yet, the Law fails to clearly distinguish between supervisory responsibility and operational decisions.

In the USA, board obligations and responsibilities are established by the business judgment rule stipulates that "directors make their decisions on an informed basis, in 'good faith' and that directors be disinterested and independent Johnson, Daily and Ellstrand (1996, p.410)." To make this concept operational, legal precedent has created the concepts of 'duty of care', and 'duty of loyalty'.

Boardroom regulations in all countries share the problem that the Law tries to describe concrete phenomena that consistently resist a precise definition. Demb and Neubauer (1992) subtitle their book on corporate boards with 'confronting the paradoxes'. The survey by Johnson, Daily and Ellstrand (1996) is unable to give a precise definition of what boards are supposed to do, exactly. Meanwhile, the Law defines categories such as supervisory vs. operational activities, or duty of care, without any guidance as to how to meaningfully interpret such concepts: "We don't know what directors are supposed to do; we only know that they have to do it 'with care Manning (1984), as quoted by Johnson, Daily and Ellstrand (1996).'." The ambiguities left in the legal definition of board responsibilities give rise to frivolous law suits, and disorientation on the side of directors: "Being on the board used to be a pleasure, then it became an honor, now it is slowly turning into a burden" Demb and Neubauer (1992).

Comparison between Malaysia and Libya

Good corporate governance is the key to the integrity of corporations, financial institutions, and markets as well as being the central health of Libyan economy and its stability (Rogers, 2008). The financial performance of Libya can be considerably influenced by the firm imposing certain rules and regulations relating to the firm's corporate governance practices. The international financial landscape is changing rapidly, economies and financial systems are undergoing traumatic years, globalization and technology are also continuing to spread, financial arenas are becoming more open, new products and services are being invented and marketed and regulators everywhere are scrambling to assess the changes and master the turbulence (Rogers, 2008). According to Rogers, (2008) the importance of governance in developing countries is to strengthen the foundation of society and chip into the global economy where sustainability will be looked into for the success of a company. This also seems to be the same strategy that Libya is also adopting when it comes to corporate governance.

Looking into Malaysia corporate governance is the recognized principle which basically focused on four areas; board of directors, directors' remunerations, shareholders, accountability and audit. Aiming with the principles components to allow a free passive action by the companies based on inconstant conditions and circumstances of personal companies. A reporting statement in the annual report, narrating the way the principles have been applied as a satisfying application to greatly attract and invite investors and others to benchmark companies performance and government practice, and also to reply significantly to their assessment in an informed way (FCCG, 2000).

The following are some of the requirements in corporate governance in Libya. Certain common requirements are generally accepted as the fundamental building blocks for protecting the rights of shareholders, regardless of the type of legal and regulatory system the economy employs:

The presentation of audited annual reports and the disclosure of unaudited semiannual reports and quarterly financial statements;

The requirement of a minimum period of notice for shareholder meetings;

The allowance of proxy voting;

The disallowance of multiple voting shares;

The right of shareholders to vote on the appointment and removal of directors, the authorization of share capital changes, amendments to the company's articles or statutes, and major corporate transactions (acquisitions, disposals, mergers, takeovers)

The ability of shareholders to nominate candidates for the position of director

The ability of shareholders to propose agenda items at shareholder meetings

The following are some of the requirements of corporate governance in Malaysia that can help in understanding the difference in corporate governance between the two countries which is not easily understood:

The Malaysian Code on Corporate Governance (Code) was developed by the Working Group on Best Practices in Corporate Governance (JPK1) and subsequently approved by the High Level Finance Committee on Corporate Governance. JPK1 was chaired by the Chairman of the Federation of Public Listed Companies. The members of JPK1 comprised a mix of private and public sector participation.

The Code was principally an initiative of the private sector. The need for a Code was inspired in part by a desire for the private sector to initiate and lead a review and to establish reforms of standards of corporate governance at a micro level. This was based on the belief that in some aspects, self-regulation was preferable and the standards developed by those involved would be more acceptable and thus more enduring.

The Code essentially aims to set out principles and best practices on structures and processes that companies may use in their operations towards achieving the optimal governance framework. These structures and processes exist at a microlevel which includes issues such as the composition of the board, procedures for recruiting new directors, remuneration of directors, the use of board committees, their mandates and their activities.

The significance of the Code is that it allows for a more constructive and flexible response to raise standards in corporate governance as opposed to the more black and white response engendered by statute or regulation. It is in recognition of the fact that there are aspects of corporate governance where statutory regulation is necessary and others where self-regulation, complemented by market regulation is more appropriate.

The need for a code also results from economic forces and the need to reinvent the corporate enterprise, so as to efficiently meet emerging global competition. The world's economies are tending towards market orientation. In market oriented economies, companies are less protected by traditional and prescriptive legal rules and regulations. Malaysia is no exception and the shift to a full disclosure regime, already underway in Malaysia, is such an example. Hence, there is a need for companies to be more efficient and well managed than ever before to meet existing and anticipated world-wide competition. The role of directors then increases in importance. The role of the board in hiring the right management, compensating, monitoring, replacing and planning the succession of senior management is crucial, as management undertakes the key responsibility for the enterprise's efficiency and competitiveness. The role of the Code is to guide boards by clarifying their responsibilities and providing prescriptions, thereby strengthening the control exercised by boards over their companies.

Standards developed for Malaysia must measure up to international thinking on this subject. Therefore, in developing the Code, careful consideration has been given to developments in other jurisdictions.

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